Business

A NOTE ON THE ACQUISITION VALUATION PROCESS

In theory, valuation of a company can be based on a wide variety of models ranging from highly analytical to highly intuitive.

In practice, valuation of acquisition and divestiture targets results from one or a combination of three methods:

1. Comparable companies

2. Comparable transactions

3. DCF spreadsheet methodology

Comparable Companies And Transactions

The comparable methods have a significant limitation in that finding a broad sample of fully comparable situations is difficult and often impossible. Also, they can produce a high dispersion of results as several financial relationships are frequently compared in the comparable companies approach.

In class the comparable companies and comparable transactions approaches were illustrated by Charts 1 – 8 in the attachments to this Note as presented in Chapter 8 of Takeovers, Restructuring, and Governance by J. Fred Weston et al., Pearson Prentice Hall, 2004, 2001.

DCF Spreadsheet Methodology

Although based on historical financials, the DCF spreadsheet methodology essentially looks forward in projecting cash flows for a defined period (usually 3 to 5 years) post acquisition. Unfortunately, any confidence generated by “tons” of Excel spreadsheet data can be highly misleading as results are materially influenced by human variables such as forecasting and residual value assumptions. DCF results are typically tested against minimum IRR hurdles. Not infrequently, hurdle requirements lead to excessively unrealistic projections.

Approaching valuation with a DCF spreadsheet methodology (net present value(NPV) analysis or internal rate of return(IRR) analysis) has three critical elements:

1. Building a forecast model

2. Determining residual value

3. Calculate the WACC

Attachment Chart 10 provides an overview of the DCF approach and Chart 10 offers a practical “snapshot” of a representative analysis.

Building A Forecast...